The Forex trading market is one of the most lucrative, with lots of avenues for making profit.
However, with it come lots of risks, which a trader should learn to identify and manage. In this
article, we will help you understand risk management in Forex trading, the different types of risks
and how you can mitigate them.
RISK MANAGEMENT IN FOREX TRADING
Forex risk management makes it possible for you to implement a certain predetermined set of rules,
which ensures that any negative impact of trading that you come across during trading is handled
effectively. A proper risk management strategy should be well planned from the start, or even before
you commence trading.
WHAT ARE THE RISKS OF FOREX TRADING?
FX trading is both volatile and risky, and if you aren’t careful, your entire capital could be wiped out.
Here are some of the risks that you will experience while trading Forex:
1. CURRENCY RISKS
These risks are mostly associated with price fluctuations in currency pairs, making it less or more
expensive to purchase foreign assets.
2. INTEREST RATE RISK
At times, the rate of interest may rise or drop quickly, and this may present some level of risk to your
trading. Fluctuations in interest rates affect FX prices because the level of investment and spending
across the economy depends on the direction that this change takes.
3. LIQUIDITY RISK
This is the risk that you face when you cannot sell or buy an asset quickly enough to prevent losses.
Although Forex is considered to be highly liquid, there are periods where it’s not fully liquid. This
mostly depends on the government policies in place and also the currency policies around foreign
4. LEVERAGE RISK
When you are trading on margin, there is always a risk of magnified losses. However, because the
initial investment is less than the value of the Forex trade you want to close, you will most likely
forget how much capital you are putting at risk.
RISK MANAGEMENT TECHNIQUES FOR FOREX TRADING
Without proper risk management, you stand to lose all your capital. Here are some of the best
strategies that you can apply to manage FX risks.
1. RECOGNIZE YOUR MARKET.
The Forex market covers currencies from all corners of the world and among the most common are
ZAR, CHF, AUD, USD, JPY, and GBP. Foreign exchange is primarily driven by the forces of demand
and supply. In a pair, the currency that appears first is known as the base currency, while the second is known as the quote currency. The chart will always display the quote currency and
represents how much you need to pay to get a unit of the base currency. For example, if the
exchange rate for GBP/USD is 1.25000, this means that for every $1.25 that you spend, you will buy
2. UNDERSTAND THE CONCEPT OF LEVERAGE.
This is where you speculate on the movement of Forex prices based on spread bets. This is
significant because it allows you to obtain a comprehensive market exposure from a small initial
deposit known as a margin. Although employing leverage in your trades is beneficial, there are
instances where it could lead to magnified losses, so it’s imperative that you be careful.
3. BUILD AN ACCEPTABLE TRADING PLAN.
A trading plan is important because it helps act as your personal Forex trading tool. In a highly
volatile Forex market, a trading plan also ensures that you are maintaining an acceptable level of
discipline. While there are many off-the-shelf trading plans, you need to start personalizing yours
and come up with something that works well for you. You should desist from copying another
person’s plan because they are most likely to have different plans, strategies, attitudes, and plans.
4. SET YOUR RISK TO REWARD RATIO.
Just like in every trade, the risk that you accept in relation to the capital that you employ should be
worthwhile. In an ideal trading environment, you should ensure that your profit is greater than your
losses. Well, there are some individual trades that you will lose, but overall, there should be profit in
5. LIMITS AND STOPS SHOULD BE USED.
You must remember that Forex trading is quite volatile, so it’s advisable to make decisions regarding
your entry and exit points well before the trade starts. There are various stops that you will need to
use, and among them are normal stops, guaranteed stops, and trailing stops.
6. MANAGE YOUR EMOTIONS.
The high levels of volatility in FX trades may make you emotional. Elements of emotions that include
fear, temptation, greed, and anxiety can cloud your judgment. This may affect your decision-making
in one way or another.
Trading Forex is risky, but if well managed, it can be profitable. This makes it extremely important to
have a solid FX trading strategy in place, understand your market and use stop loss orders as well as
limit orders. Implementing an acceptable risk-to-reward ratio is also paramount.